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Wal-Mart Margins Will Remain Under Pressure

John Brick, CFA

Wide-moat Wal-Mart reported second-quarter results that are largely tracking in line with our full-year estimates, but we plan to raise our $82 fair value estimate by $1 to incorporate faster than anticipated digital growth of 60%, ahead of our 40% estimate for the year. As this number suggests, the firm continues to focus on driving its omnichannel experience (online, delivery, and pickup in store), which enabled strong traffic through its vast network and boosted U.S. comparable-store sales.

As the retailing industry remains highly competitive, these results reinforce Wal-Mart's wide moat and the importance of its brand equity as a low cost leader and cost advantage.

Despite its strong competitive positioning, we think Wal-Mart will continue to invest in its people, technology, and lower prices. However, even with strong sales performance we expect margins to stay pressured over time. In addition to higher wages and IT spending, we see higher fulfillment costs associated with digital orders as they add a variable cost of shipping, due to the free shipping offered on millions of items.

We currently see shares as fairly valued and would recommend investors wait for a higher margin of safety before buying into this wide-moat name.